Bringing transparency to ESG ratings

By Andrew Barnett, Global Head of Product Strategy, RIMES Technologies

While responsible investing isn’t a new phenomenon, the scale of current demand for products based on Environmental, Social and Governance (ESG) criteria is unprecedented. Indeed, with the Global Sustainable Investment Alliance estimating that ESG investing will top $40 trillion this year, the criteria seem on the fast track to become as important to investment decision making as financial benchmarking.

It’s a trend that we’re seeing reflected in our own business, with demand for direct or indirect sources of ESG signals requested by our clients on the rise (the number of individual ESG data deliveries we made to clients tripled over the past year). Every day, we now send more than 600 indices with ESG exposures/tilts and the number of clients we serve with ESG feeds has increased 30% over the past two years. We’re onboarding ESG ratings and raw data at speed, and we expect consumption to follow suit.

As the market takes off, the regulators are starting to pay more attention, particularly when it comes to how firms calculate ESG scores. Recently, Steven Maijoor, chair of the EU's European Securities and Markets Authority, made this very point, telling a conference in Dublin that “the lack of clarity on the methodologies underpinning…scoring mechanisms and their diversity does not contribute to enabling investors to effectively compare investments which are marketed as sustainable.”

As the ESG market continues to mature, standards around methodologies will evolve and put regulators’ minds at rest. Certainly, it’s in the interests of every investment firm to ensure that investors can make decisions based on transparent and explainable methodologies to avoid accusations of mis-selling or “greenwashing”.

Overcoming score divergence

One key challenge facing investment firms lies in how best to source and integrate ESG data given that there’s little or no measurement standardisation from either raw corporate data or the scores provided by ratings agencies.

Score divergence is a particular problem when it comes to cross product comparison, as a single security can be rated very differently according to the methodology used. How, for example, can investors make the right choices when comparing a product using a ‘traffic light’ scoring system against one that provides a numeric rating?

Forcing a common taxonomy across providers risks stifling innovation and raising issues around intellectual property and competitive differentiation. It’s therefore preferable to focus instead on transparency and clear communication with clients. With a well-documented, transparent approach, communicated across the consumer base, investment firms can rest assured they’ve fulfilled their fiduciary responsibilities. 

To achieve these goals, firms need to ensure they’re able to source, normalise and implement ESG data at scale in their research, analysis, investing and reporting functions. This requires building a comprehensive library of ratings, scores, fundamental data and indices covering a broad range of asset classes, countries and industry sectors. This is a significant task and, let’s be honest, non-core.

Some firms are looking to create their own ESG scores for reasons of competitive differentiation. These firms will also need to be able to evidence and explain a fully governed scoring function that includes data lineage. Doing so requires a strong foundation based on raw ESG data. Sourcing and preparing this data for consumption is again a significant job.

The future of ESG

While ESG may be an emerging domain, the basic concept of sourcing, validating, cross referencing and distributing high-quality data to different business functions is what firms have been doing for years with their financial market data. And as with financial benchmark data management, firms have two choices: manage the data themselves in-house, or outsource it to managed data service providers.

Given the scale of the data management and governance tasks at hand, and the imperative of avoiding the perception of mis-selling, many firms will see the advantage of working with expert data partners. The approach simplifies data management and allows investment managers to focus on what they do best. With the ESG market still nascent, building a strong competitive position now will be key to long-term success. Data management is clearly a critical element of meeting this challenge and one that firms will need to get right now.